Destination: China
Growing opportunities for shippers, 3PLs to tap into the country's expanding and strengthening consumer base?
By Eric Johnson
China has long been dubbed the 'world's factory' for its phenomenal export prowess.
But according to government statistics, retail sales in China's domestic sector this year are likely to surpass the total value of the country's exports.
The significance of that development cannot be ignored. While most shippers and supply chain practitioners continue to view China simply as a giant launching pad for finished goods destined for developed consumer markets, there is growing activity on the domestic and inbound logistics scene.
The sophistication of that activity doesn't yet match the carefully honed export-oriented supply chains existing in China, according to logistics experts that spoke with American Shipper. But with China's consumer class gaining strength year by year, it's likely only a matter of time before the country's domestic logistics environment is as strong as its export counterpart.
By 2015, more than 550 million people in emerging economies will have an annual income higher than $4,000 per year, according to a study DHL released in November 2009. Translated to a household level, that implies a household income of $12,000 to $16,000, 'enough to fuel demand for consumer goods such as cars, consumer durables, tourism and higher education,' said Steve Huang, chief executive officer of DHL Global Forwarding China. 'China will contribute significantly to this rising middle class ' 240 million people, or 45 percent of the 550 million people in emerging economies, will live in China.'
Huang said this rise in consumer power provides 'tremendous opportunities' for the logistics industry.
'Export won't be the only growth driver,' he said. 'Import of consumer goods is also on the rise and will continue on the upward trend as demand within China grows. This trend will result in growing demand for nationwide distribution, as well as value-added services such as packaging, labeling and customs clearance. And with the redefining of the logistics industry, companies need to look into designing their supply chains to ensure optimization and operational efficiency.'
According to Matthias Umlauf, senior economist at HSH Nordbank AG in Singapore, much of China's potential stems from the fact that consumption, as a percentage of gross domestic product, is low compared to developed markets. He said Chinese consumption as a percentage of GDP has fallen from about 47 percent prior to China's accession to the World Trade Organization to 38 percent today. As a comparison, U.S. consumption as a percentage of GDP has ranged from 69 percent to 76 percent in the last decade, and is currently about 74 percent.
Beijing is implementing policies to raise that ratio to 45 percent to 50 percent, bringing China more on par with other developing nations. The government sees consumption as the next evolution for the country from exports and investment.
Citi said much the same in a late August report on the short-term future of Asia's liner carriers.
'Growing affluence creates sustainable growth of consumption-driven import demand, especially in China, where Citi expects a reversal of the downtrend in the consumption-GDP ratio in the following years,' the report said. 'Specifically, Citi projects China's private consumption to rise 5 to 10 percentage points in the following decade, to 40 to 45 percent by around 2020, from 35 percent currently. Trade volumes may become more balanced as traditional manufacturing export economies and attendant wage inflation lead to a structural rise in consumer power.'
More broadly, another DHL report in late September forecasts that consumer spending in the Asia-Pacific region will grow from $4.3 trillion in 2008 (about half of which is tied to China) to $32 trillion by 2030.
That equates to roughly 43 percent of global consumer spending projected for 2030.
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| Philip Damas division director, Drewry Supply Chain Advisors |
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| 'It's a huge market for semi-manufactured goods and finished goods, not just a springboard for exports. That's creating a major focus for logistics companies, who are starting to see China more an independent business instead of a support mechanism for exports.' | |
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The growth of the Chinese consumer 'depends on the future economic policy of the Chinese government more than growth of Chinese markets,' said Philip Damas, division director for Drewry Supply Chain Advisors. 'Chinese workers do not get a big share of the country's economic wealth. Only if this share is allowed to increase will you see a proportionately large growth in the consumer market.'
But Chinese consumption is being aided by economic stagnation in North America and Europe, where austerity measures are being implemented to cope with debt crises. Umlauf estimates that if China's currency is revalued, by 2020 the country could have 75 percent of the consumer power that the European Union has today.
That's only a decade away. The significance for shippers and logistics companies is enormous.
Huge Market. 'The realization is that China in its own right is an enormous market for manufacturers and logistics companies,' Damas said. 'It's a huge market for semi-manufactured goods and finished goods, not just a springboard for exports. That's creating a major focus for logistics companies, who are starting to see China more as an independent business instead of a support mechanism for exports. In our experience, the inland logistics and inland transport setups of companies in China are very much geared towards exports only, rather than towards import and domestic trades. This is changing, as production and consumption moves inland, and with a greater reliance on imports.'
Damas said China has plenty of importing experience, only not so much for consumer goods. 'For years, China has imported millions of tons of coal and other primary commodities moving in bulk, but inland logistics for other products is the new priority.'
As an example of the activity in the import and domestic arenas, Damas pointed to the fact that Kuehne + Nagel recently explained that part of its new strategy is to add domestic transportation services in China, India and Brazil.
On the manufacturing side, Damas said a state-owned business in China that's a client of Drewry last year was interested in international expansion, but realized that domestic growth rates are higher within China and so is looking inward now.
On the distribution side, Proctor & Gamble announced in September that it's building a distribution center in Guangzhou (in South China) that would be its largest in Asia and second-largest worldwide. The new facility is designed to cater to international and domestic distribution.
Logistics spend doesn't yet parallel the development of retail sales in China, but the domestic logistics market is growing faster, Damas said.
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| 'Clearly for us there is an emerging market and increasing requirement for in-country distribution services that our customers are accustomed to getting in other countries, and they'd like those services transplanted from say, Cincinnati to Chongqing.' | |
| Jim McAdam president, APL Logistics |
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'It's not the same China market of 10 years ago,' said Jim McAdam, president of APL Logistics. 'Up until the last three years, give or take, the vast majority of the work we did was centered on the export space ' order consolidation, vendor management, relating to assisting multinational companies, most of whom are headquartered outside China.
'But the growth of the domestic consumer market has seen an increase in requests by customers for services that aren't port adjacent. The whole market is driving more sophistication.'
McAdam said APL Logistics is focused on growing its first-mile land transport, order management, and vendor consolidation capabilities.
The Singapore-based company (and sister of liner carrier APL) operates two joint ventures in China's domestic market. One is Changan Minsheng APL Logistics, an eight-year-old Chongqing-based joint venture with Chinese automobile manufacturer Changan Motors.
APL Logistics also has a joint venture with a division of computer manufacturer Lenovo 'that's more focused on traditional China-based land transport, order fulfillment, and first-mile, last-mile support for Chinese retail distribution,' McAdam said. 'Clearly for us there is an emerging market, and increasing requirement for in-country distribution services that our customers are accustomed to getting in other countries, and they'd like those services transplanted from say, Cincinnati to Chongqing.'
Downturn Helped. Huang, of DHL, said the economic downturn and its drastic effect on export orders has made the domestic market look that much more attractive.
'Since the economic crisis in 2008, exports to the U.S. and EU are shrinking,' he said. 'Many export-oriented companies had to close or reduce their production scale. Some of these companies moved their attention to the domestic market, which remained active as it was less vulnerable to the economic crisis. However, most of these companies are latecomers in the domestic market and are thus lagging behind in the industry. They now need to boost their supply chain by studying domestic demand, building up brand recognition, designing new sales channel and setting up after-sales service.'
It's here where the opportunities for logistics companies are enormous.
'Compared with export-oriented production, supply chain management for domestic logistics will be more demanding,' Huang said. 'It requires the logistics provider to design and plan a complete supply chain for the domestic customers. And logistics companies face the challenge of differing infrastructural standards within the country due to the different pace of development and urbanization. As a result, different modes of transportation are used to ensure customer shipments are delivered on time.'
APL Logistics, for its part, has been pushing Beijing to invest more heavily in freight rail. The government is underway on an ambitious plan to build 18 intermodal rail hubs throughout the country, and APL clearly sees a chance to extend the intermodal blueprint it brought to North America, and more recently to India.
McAdam said only 3 percent to 4 percent of China's land-based container transport is handled by rail. Trying to support manufacturing expansion in western China with truck-based land transport alone won't work.
'We move every imaginable commodity that can be containerized into China today,' he said. 'But how can this migration take place if the internal infrastructure is not keeping pace? Our own view is trucking is probably a viable option 800 miles inland, and beyond that barge movement can be problematic. That's where we think rail is the right answer.'
And for logistics companies, it's not only transport, but also distribution facilities that are needed to properly serve growing domestic markets.
Inland Network Key. 'The key difference is that you need facilities located further inland,' Damas said. 'You need a broader transport network and there's not a single nationwide trucking service provider, so it's difficult to organize transport on a nationwide basis.'
The fragmentation of the trucking and warehousing industries can be quite severe, particularly in less-developed parts of the country.
'There is something like 100,000 different trucking companies within China,' Damas said. 'For locally produced commodities, you can have some very basic warehouses, not of international standards, used by second-tier manufacturers and logistics services providers. International companies will go with Class A warehouses ' used for exports or imports of valuable goods. Some companies have tried to tackle local and international distribution in one facility (like Procter & Gamble's new distribution center will aim to do), but ideally you would need different facilities for those different markets.'
Damas said another difference is that 'you have to compete entirely on cost,' meaning service can be less of a differentiating factor. 'It's a different business culture. The largest western logistics providers arguably wouldn't be best for the domestic market for this reason, whereas they are probably the best for the export market.'
And then there's the element of corruption in domestic markets.
'Import Customs in China has a reputation for corrupt practices,' Damas said. 'As with many things in China, you need a relationship. If you want to sell to a state-owned producer, you need to have a relationship. It's not enough to just have a superior product.'
As far as regions go, it makes sense that the broader consumer power resides primarily in China's more mature markets. That means the coastal hubs that have been export-driven but have seen wages and prices rise in recent years. DHL, for instance, has centers devoted to the type of high-end imported goods that Chinese consumers are increasingly expecting. The company has set up inbound-focused wine and spirit, fashion and apparel, and life science and health care centers to spur supply chain innovation.
'The coastal areas are key to DHL Global Forwarding's inbound business,' Huang said.
The company's 'branches in West and Central China have a stronger focus on the domestic business. Increasingly, the local emerging businesses in the domestic market are expanding their geographical footprint within China. At the same time, foreign businesses continue to eye the Chinese inland market.'
Huang added that DHL Global Forwarding has developed domestic air and road freight services in 2008 to better serve the domestic logistics market.
Currency Effect. Another factor to consider is China's currency. U.S. and European politicians are urging Beijing to revalue its currency, the yuan or RMB (renminbi), instead of tightly pegging it to the U.S. dollar. Beijing isn't likely to comply anytime soon ' and a U.S. House of Representatives bill that gives the Obama administration power to penalize Chinese imports if the yuan isn't revalued is likely to fail in the Senate.
But while a stronger yuan would undeniably hurt Chinese exports, it would help China's consumer power.
Umlauf, of HSH Nordbank, argued that the yuan might increasingly become the anchor currency for East Asia.
'The upward movement of the Asian currency block lowers political pressure and increases purchasing power,' he said. 'The exchange rate would provide an additional boost for China's future purchasing power.'
Others factors that could drive up purchasing power include personal income tax cuts, expanding health care and land-ownership rights in China.
'There are these gradual, small changes with significant long-term impacts on the relative market size,' he said.
But there's still work to be done.
'The domestic market is still in the early days of what will become a more sophisticated environment,' McAdam said. 'China will have to lower its costs of logistics as a percentage of GDP, improve infrastructure, provide more liberal allowances for foreign service providers to bring in best practices that we're routinely providing in other markets. That's the kind of service multinationals expect. They're now selling in China. Their requirements for 'right place, right time' are the same as they are anywhere else in the world. Customers looking to work with us in China don't want to decouple with the services we provide in other regions. We're spending a fair amount of capital to make sure our systems are up-to-date, but interchangeable with other markets in our enterprise.'
McAdam said roughly two-thirds of APL's business originating in China is tied to export activities, but he sees the domestic side of the ratio increasing in time.
'It's absolutely a perfect time to have a dialogue around these issues,' he said. 'But the story will get more interesting. It clearly will become the largest consumer market in the world in our lifetimes, and the supply chain services demand will increase too. I see a lot of change coming.'